ARTICLE: Escrow accounts and new opportunities for business

Escrow mechanism

Transactions that do not provide for a simultaneous transfer of title to a product/service and payment for it have always been considered to be risky. Lots of calculation mechanisms which satisfy both parties have been invented for them. Deferred payment, advance payment, commercial letter of credit, documentary collection: those are the most widespread in our country. However, all these instruments have their features and restrictions when used.

Risk transactions can also be secured by the escrow mechanism, which is already used in other jurisdictions. The uniqueness of the escrow mechanism is the making of settlements between parties with the participation of an escrow agent. At present, only a banking institution which is responsible for all the parties to a transaction can be an escrow agent in Ukraine. Accordingly, escrow is a guarantee of transaction security for all parties, sets the required level of comfort for the parties to a transaction and minimizes their risks. If an escrow mechanism is used, then a corresponding condition will be displayed in the underlying obligation (for example, a share purchase agreement) and is one of its material conditions.

To implement this mechanism, a client shall conclude an escrow contract with a bank. On the basis of such a contract, a bank shall open a special account – an escrow account, to which it undertakes to accept and transfer funds received from an account holder or third parties. Funds on an escrow account have a strictly designated purpose specified by an account holder. For instance, in cases provided for in a contract, a bank shall provide a client with services for transferring such funds to a beneficiary (a person specified by an account holder), as well as services for returning such funds to an account holder should there be grounds provided for by a contract.

The uniqueness of an escrow account is that neither an account holder nor beneficiary can dispose of the funds held on such an account until the conditions specified in a contract have been met.

On the one hand, funds on an escrow account guarantee a beneficiary that he/she will receive them if he/she performs his/her obligations (supply of goods, rendering of services, etc.), in which case the funds ensure that an account holder performs his/her obligations. On the other hand, it is a way of making settlements, where funds will not be transferred without good reason. Although the parties may provide for other conditions.

An escrow contract shall be terminated after the expiry of the escrow period, other obligations, as well as in the event of the bank’s liquidation.

Squeeze-out and changes in legislation

Since the middle of 2017, a squeeze-out procedure has been introduced in the corporate legislation of Ukraine. It is a common world practice, where a majority holder has the right to require minority shareholders to sell their securities, thereby becoming the sole owner of a company. However, it could not be implemented due to a lack of legal regulation by the National Bank of Ukraine.

Once Resolutions of the National Bank of Ukraine No. 133 of December 18, 2017 “On Approval of Amendments to Certain Regulations of the National Bank of Ukraine” (hereinafter – “Resolution No. 133”) and No. 147 of December 28, 2017 “On Approval of Amendments to Certain Regulations of the National Bank of Ukraine “(hereinafter – “Resolution No. 147”) came into effect, Ukrainian banks were able to provide escrow account servicing to majority holders of joint stock companies under the squeeze-out procedure (provides for the right of a buyout of shares from shareholders).

Furthermore, in addition to escrow account servicing, according to Resolution No. 133, the functions of escrow agents include:

concluding contracts with claimants;

crediting funds to an escrow account opened by claimant and transferring them to a beneficiary’s account or paying a beneficiary of relevant funds in cash;

identification of beneficiary and verification of his/her rights to receive funds.

As of today, some Ukrainian banks are already implementing the squeeze-out procedure when opening escrow accounts for transferring funds from which minority shareholders can withdraw funds for shares held by them. The cost of opening and servicing an escrow account is to be agreed with a bank on a tariff basis.

Requirements of client identification and verification when concluding an escrow contract are similar to the identification requirements when concluding a bank deposit agreement and a bank account agreement.

They are set by the Instruction on Procedure for Opening, Use and Closing of Accounts in Domestic and Foreign Currencies approved by the Resolution of Board of the National Bank of Ukraine No. 492 of November 11, 2003.

Only the following transactions are to be conducted on an escrow account:

crediting by a bank of funds received from an account holder and/or third parties, which, subject to conditions specified by an escrow contract, shall be transferred to beneficiaries or returned to an account holder;

transactions related to enforcing property rights by seizure of funds held on an escrow account, or to claims of an account holder or beneficiary to a bank under an escrow contract;

payment of a fee to a bank for servicing an escrow account.

New opportunities for business

Taking into account the experience of European countries, the USA and others, escrow accounts minimize risks and damages in case of violation or failure to perform obligations by a counterparty in the following areas: indemnification, M&A, construction, litigation, software licensing, environmental protection, sale and purchase of real estate, including land, franchising, protection of intellectual property rights.

For instance, let us consider a scheme for using an escrow account for real estate transactions. A seller negotiates with a buyer the terms of a transaction, the buyer transfers funds to an escrow account, it can be checked by the buyer and seller at any time, but the funds may be withdrawn only after all the terms have been met and the documents have been signed. The bank, as an escrow agent, monitors compliance with the terms of a transaction as a whole. Depending on the specific situation and intentions of the parties, the terms of an escrow contract may be made more complex. For example, there may be two or more escrow agents, documents may be transferred to an escrow agent’s safety deposit box, funds may be transferred in instalments and accumulated on an escrow account, or transferred immediately to a seller, and other terms.

In some countries, escrow agent services are mandatory for all real estate contracts, and not only banks and financial institutions can be escrow agents. The importance of the credibility of an escrow agent, the degree of its professionalism, as well as the existence of relations of trust between all parties to a transaction should be noted. Despite the existence of a contract and terms enshrined in it, the parties will entrust the performance of escrow agent’s functions to a credible entity.

In Ukraine, in the future, the functions of an escrow agent will be performed not only by banks, but also by law firms, notaries and attorneys. And an escrow account will be used to store not only funds, but documents or other property as well.

Once the changes are introduced to effective regulations, the use of escrow accounts will become more widespread in all types of M&A transactions, real estate purchase and construction, export and import transactions. At the same time, banks will balance the interests of parties when using escrow accounts.